Opinion
Case No. 97-14180-SSM, Adversary Proceeding No. 97-1468
May 20, 1998
Daniel M. Lewis, Esquire, Arnold Porter, Washington, D.C., for Xerox Realty Corporation
James R. Schroll, Esquire, Bean, Kinney Korman, P.C., Arlington, VA, for University Development, L.L.C.
Lawrence A. Katz, Esquire, Tucker, Flyer Lewis, Washington, D.C., for The Resorts at Lansdowne, L.C.
MEMORANDUM OPINION
This matter is before the court on cross-motions for summary judgment with respect to all of the plaintiff's causes of action and with respect to five of the debtor-defendant's counterclaims. The dispositive issue is whether the debtor, in its capacity as debtor in possession, can trump rights of Xerox Realty Corporation ("Xerox") as a contract purchaser of the debtor's real estate, a 545 acre tract of land in Loudoun County, Virginia. Xerox argues that under the doctrine of equitable conversion, the debtor holds only bare legal title to the property and should be compelled to convey it to Xerox. The debtor, by contrast, asserts that Xerox's equitable interest in the property was unperfected on the filing date of the chapter 11 petition and can be avoided under the Bankruptcy Code's "strong arm" powers or as a fraudulent conveyance, and that Xerox has at best an unsecured claim for breach of the purchase agreement. Oral argument on the summary judgment motion was heard on March 9, 1998, at which time the court took the motion, as well as the debtor's motion to strike two affidavits filed by Xerox, under advisement. For the reasons stated in this opinion, the court will enter summary judgment for Xerox with respect to the various avoidance theories asserted by the debtor but will reserve for trial the issue of whether Xerox may be compensated for certain proffer liabilities.
There are two separate Xerox entities involved in this case. Xerox Realty Corporation is the plaintiff in this action and was the original owner of the property in question. Xerox Credit Corporation, a sister entity, holds a first-lien deed of trust against the property. Their respective interests, however, arise out of the same underlying transaction.
Facts A.
University Development, L.L.C. (the "debtor") filed a voluntary petition for relief under chapter 11 of the Bankruptcy Code in this court on June 5, 1997, and remains in possession of its estate as a debtor in possession. Its sole asset, other than potential malpractice claims against its former attorneys, consists of an undeveloped 545 acre tract of land located in Loudoun County, Virginia. The debtor values the property on its schedules at $12 million and shows the property as being subject to a first lien deed of trust in favor of Xerox Credit Corporation ("Xerox Credit") in the amount of $4,540,581.
The debtor, Xerox, and a creditor named Toll Land IX, L.P. have filed competing plans of reorganization. All parties agree, however, that the resolution of this adversary proceeding is necessary before a plan may be confirmed.
The debtor's parcel of land is part of a larger planned development, approximately 2,200 acres in size, known as "Lansdowne" that was being developed by Xerox. Lansdowne is the site of a resort and conference center, some office buildings, and a Xerox institution known as the Xerox Document University, as well as an additional 1,350 acres of undeveloped property that Xerox still owns adjacent to the debtor's 545 acres. The 545 acre parcel was originally sold by Xerox to Japanese investors for approximately $40 million in 1992 as the site of a Japanese-American university which was to be known as the Washington International University in Virginia ("WIUV"). The sale to WIUV was financed in part by a note and deed of trust taken back by Xerox. The note was sold to an entity known as Grausz Investors, which in turn sold it to another entity known as GFI Commercial Mortgage Limited Partnership ("GFI").
Although not relevant to the present motion, the sale to WIUV included the recording of a restrictive covenant that prevented the property from being used for any purpose other than as a university (with certain ancillary uses) until September 25, 2001. Count V of the debtor's counterclaim in this adversary proceeding seeks a determination that the restriction was no longer in force. The debtor and Xerox filed separate cross-motions for summary judgment relating to that issue. By separate order dated May 14, 1998, the court determined that the restriction remained enforceable notwithstanding that Xerox had joined in an application with the debtor to rezone the property for residential use.
The WIUV note eventually went into default. The debtor then purchased the property from WIUV on May 4, 1994, for $5,876,000, which resulted in the payoff of the note held by GFI. The purchase was financed in part by a $4,724,943 loan from Imperial Bank. As a condition of making the loan, Imperial Bank required a credit enhancement. That credit enhancement was supplied by Xerox Credit, an affiliate of Xerox, which agreed to purchase the note from Imperial Bank on request. Xerox Credit was willing to enter into the credit enhancement arrangement because Xerox had already contracted on December 30, 1993, to sell the adjacent 1,350 acres at Lansdowne to an entity known as Lansdowne Development Company, L.L.C. ("LDC"). The debtor and LDC had the same management and, for the most part, the same investors, and Xerox regarded them as essentially a single entity.
Xerox's sales contract with LDC required that certain monetary proffers that had been made to Loudoun County in connection with a successful joint application by UDC and Xerox to rezone the property be secured by a deed of trust against both the 1,350 acres that LDC was purchasing and the 545 acres that the debtor was purchasing. As part of that same contract, Xerox required that the debtor sign an option contract agreeing to sell the 545 acre parcel back to Xerox in the event LDC defaulted on the larger purchase. That option agreement, dated May 3, 1994, is in form a straightforward purchase option in which, for the present payment of $100 "and other good and valuable consideration," the debtor agreed to sell the property to Xerox for the lesser of $4,724,943, or the balance due on the Imperial Bank loan, if LDC defaulted under the sales contract. A memorandum of the option agreement was recorded on May 9, 1994, among the Loudoun County land records. That memorandum recites that the option expired on August 1, 1996.
The closing on the sale of the 1,350 acres to LDC was extended twice and was ultimately scheduled for March 1, 1996. In the interim, the debtor had entered into a contract with an entity known as Miller Smith at Lansdowne, Inc., to sell 287 of the 545 acres for $11,175,450, but the contract required that the sale be free and clear of liens. In the months leading up to the scheduled closing date, the debtor and LDC attempted without success to get Xerox to waive the requirement for a deed of trust to secure the monetary proffer obligations. Those proposals were not acceptable to Xerox, and at the scheduled closing, LDC refused sign a deed of trust. Xerox, anticipating this would happen, handed the debtor's managing member a letter exercising the purchase option and scheduling a closing for March 4, 1996, at its counsel's office. Xerox wire-transferred the purchase price to its attorney prior to the closing, but the debtor did not show up. The settlement agent subsequently returned the funds to Xerox.
The contract was subsequently assigned to The Resorts at Lansdowne, L.C., a Miller Smith affiliate.
On March 21, 1996, Xerox filed an action for specific performance in the United States District Court for the Eastern District of Virginia. That same day, it filed a memorandum of lis pendens in the land records of Loudoun County. A week later, LDC filed suit against Xerox in the Circuit Court of Loudoun County. Xerox then filed a cross-bill for specific performance in the Loudoun County suit and did not pursue its action in Federal court. A five-day trial was held in the Loudoun County suit in February 1997. The chancellor issued a detailed letter opinion dated April 22, 1997, which found that LDC had breached the sales agreement with Xerox and that Xerox was entitled to specific performance of the option contract. Xerox, having obtained the relief it desired, then voluntarily dismissed the Federal court action without prejudice on May 29, 1997. Before a final decree could be entered in the state court suit, however, the debtor filed its chapter 11 petition in this court on June 5, 1997. On June 20, 1997, Xerox filed an "amended" memorandum of lis pendens that referenced the state court action rather than the Federal court action.
Shortly after the debtor filed its bankruptcy petition, Xerox Realty filed a motion to dismiss the case as having been filed in bad faith and for relief from the automatic stay in order to have a final decree entered in the Loudoun County suit. The debtor cross-moved under § 365, Bankruptcy Code, to reject the option contract as being burdensome to the estate. A combined hearing on the motions was held on October 16 and 17, 1997, at the conclusion of which the court made the following rulings from the bench: (a) the case would not be dismissed as having been filed in bad faith; (b) the option contract could not be rejected by the debtor in possession because it was in the nature of a security device; and (c) Xerox Realty would be granted relief from the automatic stay solely to have a final decree entered in the Loudoun County suit and to permit any post-trial motions or appeals to be heard.
B.
On December 17, 1997, Xerox Realty filed this adversary proceeding seeking: (1) a declaratory judgment that it is the equitable owner of the property; (2) relief from the automatic stay to compel conveyance of the property to Xerox Realty; and (3) an order compelling turnover of the property. Xerox Realty's position, as set forth in its complaint, is that on March 1, 1996, the date it exercised the option, all incidents of ownership other than bare legal title vested in Xerox Realty under the doctrine of equitable conversion, and that the debtor, on the date it filed its chapter 11 petition, had no interest in the property. The debtor filed an answer and counterclaim which, as amended, denyied that Xerox was entitled to the relief requested, while also asserting the following counterclaims: (1) avoidance of the option agreement under the "strong arm" powers of § 544(a), Bankruptcy Code; (2) avoidance of the transfer of the property as a fraudulent conveyance under § 548, Bankruptcy Code; (3) objection to the claim of Xerox Realty and a determination of the secured status of the claim; (4) avoidance of a post-petition transfer when Xerox filed an amended memorandum of lis pendens on June 20, 1997; (5) a declaratory judgment that a recorded restrictive covenant limiting the use of the property to a Japanese-American university allows development of the Property in accordance with current zoning, or in the alternative, is of no further effect; and (6) avoidance of the transfer of the property as a preference under § 547, Bankruptcy Code. The debtor has moved for summary judgment with respect to Xerox's claims and with respect to Counts I, II, IV, and VI of its counterclaim, as well as for partial summary judgment with respect to Count III of its counterclaim, and Xerox has cross-moved for summary judgment on its own claims and Counts I, II, III, IV, and VI of the debtor's counterclaims.
C.
In addition to Xerox Realty, two other parties assert an ownership interest — in the form of a constructive trust — in the property. While neither claimant is a party to the present adversary proceeding, some brief discussion is warranted in order to set the controversy in context.
Henry Grausz, M.D. was a managing member of GFI and was also a trustee of WIUV, the former owner of the property. Dr. Grausz also holds an ownership interest in the debtor. GFI is a Delaware limited partnership formed in California to purchase commercial mortgages and to sell bonds backed by those mortgages to third-party investors. Among the mortgages purchased by GFI was the note originally made by WIUV and secured by a first lien deed of trust against the property. When this note fell into default, Dr. Grausz caused the debtor to be formed to purchase the property from WIUV. The defaulted note held by GFI was paid off by the proceeds of the new Imperial Bank loan.
Several limited partners of GFI subsequently brought a derivative suit on behalf of GFI against Dr. Grausz in the Superior Court of Marin County, California, alleging that Dr. Grausz breached his fiduciary duty as GFFs managing member, by usurping GFFs opportunity to acquire the parcel. The complaint alleged that GFI could have acquired title to the property, which was worth far more than the balance due on the defaulted note, by a deed in lieu of foreclosure. The debtor was not a party to the California action. On September 24, 1997 — approximately three months after the debtor filed its chapter 11 petition — the California court issued an opinion and order in GFFs favor and imposed a constructive trust against the debtor's property for the benefit of GFI "against any entity which acquired any interest in the WIUV property with actual or constructive knowledge of the impropriety of Grausz' actions in arranging for transfer of ownership of the property in 1993-1994." John Sampson, as receiver for GFI, commenced an adversary proceeding in this court seeking to establish that the debtor holds title to the property only under a constructive trust for the benefit of GFI.
The court is informed that GFI is a debtor in its own chapter 11 case in California Mr. Sampson had been appointed as receiver for GFI by the state court and is now apparently serving as GFFs designated representative in the chapter 11 case.
GFI takes the position that one of its limited partners, Dennis Carlston, filed a memorandum of lis pendens among the land records of Loudoun County on April 12, 1996, giving notice of the California litigation.
Meanwhile, certain investors in GFI, namely G.B. Munn, Eileen M. Sullivan and Rive Droit, Inc., individually and as partners of Proforma Partners (collectively, "ProForma"), brought suit against the debtor, LDC, Xerox and others in the Loudoun County Circuit Court in April 1996 seeking imposition of a constructive trust against the debtor's property and damages in excess of $12 million. The allegations in that action involve essentially the same facts as the GFI litigation in the California court. At a hearing on February 9, 1998, this court granted Xerox's motion to intervene in the GFI adversary proceeding and to join Proforma as a party. By order entered May 4, 1998, this court dismissed Proforma's counterclaims for failure to state a claim upon which relief can be granted on the basis that its claims were derivative in nature and GFI was actively pursuing its claims.
Conclusions of Law and Discussion I.
Under Fed.R.Civ.P. 56, made applicable to adversary proceedings by F.R.Bankr.P. 7056, a party may move, with or without supporting affidavits, for summary judgment at any time after the parties are at issue. Rule 56(c) provides:
The judgment sought shall be rendered forthwith if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law. A summary judgment, interlocutory in character, may be rendered on the issue of liability alone although there is a genuine issue as to the amount of damages.
The burden of establishing the nonexistence of a genuine issue of material fact rests on the moving party. Celotex Corp. v. Catrett, 477 U.S. 317, 325, 106 S.Ct. 2548, 88 L.Ed.2d 285 (1985). In considering a motion for summary judgment, the court should draw all inferences from the underlying facts in a light most favorable to the nonmoving party. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255, 106 S.Ct. 2505, 2513, 91 L.Ed.2d 202 (1986); Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 106 S.Ct. 1348, 89 L.Ed.2d 530 (1986). Nevertheless, not just any factual dispute is sufficient to bar summary judgment; the dispute must be as to a "material" fact. Anderson, 477 U.S. at 247-248; 106 S.Ct. at 2510. This means that the dispute must concern a fact which, if established, would defeat a required element of the moving party's case or constitute an affirmative defense.
II.
At the core of Xerox's complaint is its argument that under the doctrine of equitable conversion, the exercise of the purchase option vested equitable ownership of the 545 acres in Xerox as contract purchaser. Accordingly, it is argued, the debtor had no equitable interest in the property on the date the chapter 11 petition was filed, and the 545 acre tract never became property of the bankruptcy estate.
A.
The doctrine of equitable conversion, as Xerox argues, is well-recognized by Virginia law. Clay v. Landreth, 187 Va. 169, 172, 45 S.E.2d 875, 877 (1948); Moore v. Kernachan, 133 Va. 206, 211-12, 112 S.E. 632, 633-34 (1922). It has been applied in a variety of contexts, including disputes involving the transfer of title to real property. The doctrine originated in English law to redress the many problems that may arise — and that the parties have typically failed to address in their contract — after a contract for the sale of real estate is signed but before the deed is delivered. 14 Powell on Real Property ¶ 881[1], at 81-95 to 96 (Patrick J. Rohan ed., 1997). Equitable conversion is based upon the well-known maxim that "equity treats that as done which ought to be done by the terms of [the] contract." Sale v. Swarm, 138 Va. 198, 208, 120 S.E. 870, 873 (1924); Moore, 133 Va. at 211, 112 S.E. at 633. 14 Powell on Real Property ¶ 881 [1], at 81-98. As it relates to contracts to purchase real estate, the doctrine, at its core, treats the contract purchaser as the owner in equity (with the seller as the trustee for the buyer), and the seller as the owner of the purchase money due under the contract (with the buyer as the trustee for seller). Clay, 187 Va. at 173, 45 S.E.2d at 877; Sale, 138 Va. at 208, 120 S.E. at 873; Johnson v. Merritt, 125 Va. 162, 173, 99 S.E. 785, 788 (1919); Dunsmore v. Lyle, 87 Va. 391, 392, 12 S.E. 610, 611 (1891); see also Poague v. United States, 1990 WL 127016, at *3 (E.D. Va. 1990) (Hilton, J.) (same, following Virginia law); 14 Powell on Real Property ¶ 881[1], at 81-96.
Contrary to the debtor's assertion in its brief that the doctrine is applied primarily to determine how property should pass under wills, Debtor's Memorandum in Support at 29-30, the doctrine of equitable conversion has a broad application. See, e.g., Dominion Bank v. Wilson, 867 F.2d 203 (4th Cir. 1989) (determining whether a bank remained secured in the debtor's option); Poague v. United States, 1990 WL 127016 (E.D. Va. 1990) (Hilton, J.) (determination of federal income tax liability), aff'd, 947 F.2d 942 (4th Cir. 1991) (table); Ryland Group, Inc. v. Wills, 229 Va. 459, 331 S.E.2d 399 (1985) (determining whether the Rule Against Perpetuities violated); Bauserman v. Digiulian, 224 Va. 414, 297 S.E.2d 671 (1982) (determination of how property passed under will); 14 Powell on Real Property ¶¶ 881, 881[1], at 81-95, 81-96, 81-106 to 110 (Patrick J. Rohan ed., 1997) (noting that the doctrine is applied in circumstances such as the death of one of the contracting parties, natural disasters to the property, governmental actions affecting the value of the property, or when a creditor obtains a judgment against either party, and that "[n]umerous authorities over the past two centuries . . . have carefully explored various problem situations and found the answer through application of the equitable conversion idea."); Curtis J. Berger Quintin Johnstone, Land Transfers and Finance 614-15 (4th ed. 1993).
In order for equitable conversion to apply, three requirements must be met. There must be a valid contract; the contract must be enforceable; and the contract must affect real estate. 14 Powell on Real Property ¶ 881[1], at 81-99 to 100. The doctrine, however, is applied only when enforcement of the contract is in harmony with the intention of the parties and will not produce inequitable results. Clay, 187 Va. at 173, 45 S.E.2d at 877. Equitable conversion will not be applied if, by doing so, an undue hardship or a manifest injustice will befall one of the parties through a change in circumstances not contemplated by either party at the time the contract was made. Standard Federal Savings and Loan Association v. Community Investments Associates (In re Community Investments Associates I), 14 B.R. 211, 214 (Bankr. E.D. Va. 1981) (Bostetter, C.J.); Clay, 187 Va. at 173, 45 S.E.2d at 877-78; Miller v. Kemp, 157 Va. 178, 193-94, 160 S.E. 203, 207 (1931). In this respect, the then-Supreme Court of Appeals of Virginia has explained:
If something has intervened which ought to prevent it, the doctrine of equitable conversion will not be applied. It does not exist as a matter of right and is not applicable to all circumstances. It is a fiction invented by courts of equity to be applied only when necessity and justice require its exercise. When it arises from a contract . . . the general rule is that the legal fiction is based upon the presumed intent of the parties. . . . The doctrine of equitable conversion is altogether a doctrine of equity and depends wholly upon the rules of equity. Its real purpose is to give effect to the manifest intent of a . . . vendor and to treat that as done which . . . by previous contract with another both have mutually bound themselves to do.
Clay, 187 Va. at 174, 45 S.E.2d at 878 (citations and internal quotations omitted); see also Community Investments Associates I, 14 B.R. at 214 (noting that equitable conversion is an appropriate remedy when no events have intervened after the contract was made "which ought to prevent a performance" and if it appears to be the intent of the parties). Nevertheless, once it is determined that an enforceable contract exists that is certain and unambiguous, the remedy of specific performance is available to the aggrieved party. Clay, 187 Va. at 177-78, 45 S.E.2d at 880; Dunsmore, 87 Va. at 392-93, 12 S.E. at 611.
B.
The present case, to be sure, does not involve a contract for the sale of real property, but rather an option to purchase. Nevertheless, once an option is properly exercised, it becomes in substance a contract for the sale of real property, and the optionee thereupon becomes vested with equitable ownership of the property. Ryland Group, Inc. v. Wills, 229 Va. 459, 464, 331 S.E.2d 399, 402 (1985); see also Dominion Bank v. Wilson, 867 F.2d 203, 205 (4th Cir. 1989) (bank's security interest in debtor's contract rights did not extend to option contract after the option was exercised, as optionee's rights were no longer personal property but, under the doctrine of equitable conversion, real property); Bauserman v. Digiulian, 224 Va. 414, 419-20, 297 S.E.2d 671, 674-75 (1982) (rejecting English rule that exercise of option relates back to the granting of the option and instead adopting "American" rule that equitable conversion occurs when option is exercised, not when it is granted).
The conclusion that equitable conversion occurs upon a proper exercise of an option is in accord with the law of other jurisdictions. See, e.g., In re Merten, 164 B.R. 641, 643 (Bankr. S.D. Cal. 1994) (holding that a creditor formerly secured in the debtor's "general intangibles" — which included an option — was no longer secured once the option was exercised because the option had been converted from personal to real property); Currington v. Johnson, 685 P.2d 73, 79 (Alaska 1984) ("Under the doctrine of equitable conversion, [the plaintiffs] became equitable owners of the property when they exercised their option."); Leslie v. Gross, 157 S.E.2d 582, 586 (W.V. 1967) ("there apparently is no conflict here or elsewhere as to the rule that when the optionee accepts the option within the time provided therein and notifies the optionor thereof equitable title passes to the property"); Rosenthal v. Shapiro, 52 N.W.2d 859, 862 (Mich. 1952) ("when the plaintiff in this case exercised its option to purchase . . . a complete and absolute contract was created binding upon the plaintiff to buy and the defendant to sell, thereby vesting the equitable ownership of the premises in the plaintiff) (original source omitted); Chain O'Mines, Inc. v. Williamson, 72 P.2d 265, 266 (Colo. 1937) ("When an option to purchase land is given, according to the doctrine most in accord with authority and principle the[equitable] conversion is deemed to have taken place at the time the option is declared and not from the date of the contract giving the option.") (original source and quotation omitted); Vaughan v. Creekside Homes, Inc., 1994 WL 586832, at *5 (Del. Ch. 1994) ("The exercise of the option worked an equitable conversion of title to the real estate. . . . Conversion does not take place [with respect to an option contract] at the date of the contract, but at the date when the condition is fulfilled which makes the contract effective.") (original source and quotation omitted) (alternation in original); Butterer v. Santoro, 94 A.2d 525, (N.J.Super.Ct. Ch. Div. 1953) ("the determination . . . to exercise the option to purchase the premises in question . . . constituted a valid executory contract for the sale of lands; that in equity the making of such contract worked an equitable conversion").
C.
The debtor argues, however, that whatever rule may govern the relationship of the parties outside bankruptcy, once a contract seller of real estate files a bankruptcy petition, the rights of the contract purchaser are controlled by the Bankruptcy Code. In particular, it is argued, a contract purchaser of real estate from the debtor is recognized as simply having a "claim," which, like any other claim, may be modified and discharged in the bankruptcy. As the debtor correctly notes, § 101(5), Bankruptcy Code, defines a "claim" as
(A) right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured; or
(B) right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured;
(emphasis added). It has been repeatedly held by the Supreme Court that in enacting the Bankruptcy Code, Congress intended to adopt the broadest possible definition of a "claim." Johnson v. Home State Bank, 501 U.S. 78, 83, 111 S.Ct. 2150, 2154, 115 L.Ed.2d 66 (1991); Pennsylvania Department of Public Welfare v. Davenport, 495 U.S. 552, 558, 110 S.Ct. 2126, 2130, 109 L.Ed.2d 588 (1990), Ohio v. Kovacs, 469 U.S. 274, 279, 105 S.Ct. 705, 708, 83 L.Ed.2d 649 (1985). The plain language of § 101(5) includes certain equitable rights within the classification of a "claim" in a bankruptcy case. For example, in Kovacs the Court, was confronted with the issue of whether an injunction against the debtor to clean up a hazardous waste site could be treated as a "debt" subject to discharge in the debtor's bankruptcy. Kovacs, 469 U.S. at 275, 105 S.Ct. at 706. The Court held that the debtor's "liability" under the injunction obtained by the state was indeed a "debt" (i.e., a "liability on a claim") that was subject to being discharged. Id. at 282-83, 105 S.Ct. at 709-10. The Court reasoned that because the state had appointed a receiver pre-petition to clean up the site after the debtor failed to do so, all that was left to recover against the debtor was a monetary award. Id., 105 S.Ct. at 709-10. Citing to the legislative history of § 101(5)(B), the Court noted the following:
Section 101([5])(B) . . . is intended to cause the liquidation or estimation of contingent rights of payment for which there may be an alternative equitable remedy with the result that the equitable remedy will be susceptible to being discharged in bankruptcy. For example, in some States, a judgment for specific performance may be satisfied by an alternative right to payment in the event performance is refused; in that event, the creditor entitled to specific performance would have a `claim' for purposes of a proceeding under title 11."
Kovacs, 469 U.S. at 280, 105 S.Ct. at 708 (original source omitted) (omission in original); see also United States v. LTV Corp. (In re Chateaugay Corp.), 944 F.2d 997, 1007-08 (2d Cir. 1991) (noting the distinction that an obligation stemming from an order to clean up a site from environmental hazards is a "claim" potentially subject to discharge while an injunction against future pollution cannot be converted to a monetary obligation, and therefore, is not a claim); TKO Properties, LLC v. Young (In re Young), 214 B.R. 905, 911-12 (Bankr. D. Idaho 1997) (holding that an entity's right to specific performance against the debtor under a contract for the sale of land can be treated as a "claim" under § 101(5)(B) because state law allows both the equitable remedy of specific performance and money damages for breach of a sales contract); Calumet Farm, Inc. v. Northern Equine Thoroughbred Productions LTD (In re Calumet Farm, Inc.), 150 B.R. 403, 411-12 (Bankr. E.D. Ky. 1992) (reasoning that the equitable remedy of specific performance "likewise is provable as an unsecured claim" under § 101(5)(B)); cf. WBQ Partnership v. Commonwealth of Virginia, Dept. of Medical Assistant Services (In re WBQ Partnership), 189 B.R. 97, 106-07 (Bankr. E.D. Va. 1995) (Bostetter, C.J.) (holding that a state agency's right to recapture a depreciation overpayment under state law was a "claim" and the debtor in possession could sell its interests free and clear under § 363 because under § 363(f)(5), the state "could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest"); 2 Collier on Bankruptcy ¶ 101.05[5], at 101-36.1. Nevertheless, if the right to an equitable remedy for breach of performance does not give rise to a right to payment, such right is not a "claim" under § 101(5). Sheerin v. Davis, 3 F.3d 113, 116 (5th Cir. 1993); Chateaugay, 944 F.2d at 1008; In re Printronics, Inc., 189 B.R. 995, 1001-02 (Bankr. N.D. Fla. 1995) (holding that a covenant not to compete cannot be transformed into a claim for future damage, and is not a "claim" under the Code); In re Roxse Homes, Inc., 74 B.R. 810, 819 (Bankr. D. Mass. 1987), a ff'd sub nom. Roxse Homes, Inc. v. Roxse Homes, L.P., 83 B.R. 185 (D. Mass. 1988), aff'd 800 F.2d 1072 (1st Cir. 1988); 2 Collier on Bankruptcy ¶ 101.05[5], at 101-36.1.
D.
Intimately connected with the Bankruptcy Code's definition of "claim" as including a breach of an equitable duty is the power conferred on a bankruptcy trustee or debtor in possession to reject an executory contract. Specifically, § 365(a), Bankruptcy Code, permits a bankruptcy trustee, with court approval, to reject any unexpired lease or executory contract to which the debtor is a party. In a chapter 11 case, that power may be exercised by a debtor in possession. § 1107(a), Bankruptcy Code. Rejection operates as a breach, effective immediately prior to the date the bankruptcy was filed, and gives rise to a corresponding claim for damages. §§ 365(g) and 502(g), Bankruptcy Code. Special provisions protect the non-debtor party where the debtor is the seller of real property. § 365(i) and (j), Bankruptcy Code. In particular, a contract purchaser of real estate who is in possession may remain in possession and perform the contract notwithstanding the rejection or may, alternatively, treat the contract as terminated. § 365(i)(1), Bankruptcy Code. A purchaser who is not in possession and whose purchase contract is rejected has a lien on the property for the recovery of any portion of the purchase price that has been paid. § 365(j), Bankruptcy Code.
As noted above, the court previously considered, and denied, the debtor's motion to reject the option contract as an executory contract. However, a brief review of the prior ruling is appropriate to provide a context for the present discussion.
The term "executory contract" is not defined in the Bankruptcy Code. The Fourth Circuit in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043, 1045 (4th Cir. 1985), cert. denied 475 U.S. 1057, 106 S.Ct. 1285, 89 L.Ed.2d 592 (1986) essentially adopted the test first articulated by Professor Vern Countryman:
A contract under which the obligations of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete the performance would constitute a material breach excusing the performance of the other.
Vern Countryman, "Executory Contracts in Bankruptcy: Part I," 57 Minn.L.Rev. 439 (1973). Courts have divided on the issue of whether an option contract should be considered an executory contract. Compare Brown v. Snellen (In re Giesing), 96 B.R. 229 (Bankr. W.D. Mo. 1989) (option contract is fully performed by the optionee once he or she has paid the consideration for being granted the option), with In re Easebe Enterprises, Inc., 900 F.2d 1417 (9th Cir. 1990) (rejecting Countryman test as too "exclusive" and holding unexercised option contract to be executory). As fascinating as the issue is, however, there is no need in the present case to decide whether an option contract is executory, because once the optionee gives notice of its intent to purchase the property, at that point the option contract is no different from any other unperformed bilateral contract for the sale of real estate that a trustee or debtor in possession is empowered to assume or reject. In re Riodizio, 204 B.R. 417, 422 (Bankr. S.D. N.Y. 1997).
Easebe was recently overruled by the 9th Circuit. Unsecured Creditors Committee v. Southmark Corp. (In re Robert L. Helms Constr. Dev. Co., Inc.), 139 F.3d 702 (9th Cir. 1998) (en banc) (rejecting broad rule that all options are executory contracts and instead focusing on whether both sides must still perform — as, for example, when the optionee has announced that he is exercising the option, but has not yet paid the purchase price).
In Benevides v. Alexander (In re Alexander), 670 F.2d 885, 887 (9th Cir. 1982), the Ninth Circuit was faced with facts which, at least on the procedural level, were similar to those presented by this case. The contract seller of real estate had breached the contract by failing to deliver a deed or surrender possession after the buyer deposited the purchase price with the settlement agent. After the buyer commenced a state court suit for specific performance, the seller filed a chapter 13 petition on the date the trial was to begin. The debtor's plan rejected the contract. The buyers then brought an action in the bankruptcy court seeking relief from the automatic stay to proceed with the specific performance action. The bankruptcy court held that the sales contract was not executory and therefore could not be rejected by the debtor because the buyers had tendered full performance. The Ninth Circuit, in reversing, held that the contract did not cease to be executory simply because the buyers had made a tender of performance (by depositing the purchase funds with the escrow agent); rather actual performance was required, since the mere tender of funds did not confer any actual benefit on the debtor. Alexander, 670 F.2d at 887.
Similarly, in TKO Properties, L.L.C. v. Young (In re Young), 214 B.R. 905 (Bankr. D. Idaho 1997), the debtor and her common-law husband signed a contract to sell a parcel of real estate. The sale never closed, and the buyer brought suit in state court for specific performance. The debtor, using a durable power of attorney, conveyed the property to herself, and, after her common-law husband died five days later, filed a chapter 13 bankruptcy petition. The case was subsequently converted to chapter 7. The buyers then commenced an adversary proceeding in the bankruptcy court seeking, among other relief, specific performance of the sales contract. The court, following Alexander, held that the sales contract was executory. The court further observed:
In some situations, the Bankruptcy Code provides special treatment to a nondebtor purchaser under an executory land sale contract. Under Section 365(i), if the executory contract is rejected, a purchaser in possession of the property may either treat the contract as terminated, or may remain in possession and continue to make payments under the contract. Under such circumstances, the Bankruptcy Code grants the purchaser a means of compelling a trustee to deliver title to the property. However, this provision of the Code requires the purchaser to be in possession of the property on the date of bankruptcy.
* * *
From a review of Section 365, it is evident that Congress was cognizant of the problems created by the rejection of an executory contract for the sale of real property in the seller's bankruptcy case. Where the purchaser has taken possession of the property prior to bankruptcy, the purchaser can elect to perform the contract and compel the trustee to transfer title to the land. However, this status was not extended to purchasers not in possession. Instead, those purchasers are limited to a lien on the property for that part of the purchase price paid, and a claim in the bankruptcy case for any rejection damages. The Court concludes that the only remedies available to [the buyer] under Section 365, then, are the lien arising under Section 365(j) and any claim it can prove for breach damages pursuant to Section 502(g).
Young, 214 B.R. at 910-11 (emphasis added).
E.
One additional point merits discussion. Xerox Realty has pointed to a line of cases holding that once a court has decreed specific performance, a contract for the sale of real estate is no longer executory. See, e.g., Sundial Asphalt Co. v. V.P.C. Investors Corp. (In re Sundial Asphalt Co., 147 B.R. 72, 80 (E.D. N.Y. 1992); In re Roxse Homes, Inc. 74 B.R. 810, 816-18 (Bankr. D. Mass. 1987), aff'd sub nom. Roxse Homes, Inc. v. Roxse Homes, L.P., 83 B.R. 185 (D. Mass. 1988), aff'd 800 F.2d 1072 (1st Cir. 1988). In the present case, however, a final decree of specific performance had not been entered on the date the debtor filed its petition. While the state court chancellor had issued a detailed letter opinion finding that Xerox Realty was entitled to specific performance, a decree had not yet been entered. Xerox Realty argues that entry of a decree consistent with the letter opinion would have been a mere "ministerial act." In Virginia, however, courts of record speak only through their decrees and orders. Town of Front Royal v. Front Royal and Warren County Indus. Park Corp., 248 Va. 581, 586, 449 S.E.2d 794, 797 (1994) (declining to consider transcript of bench ruling); Hill v. Hill, 221 Va. 569, 578, 318 S.E.2d 292, 297 (1984); Martin v. Coleman, 234 Va. 509, 510, 362 S.E.2d 732, 733 (1987); Decker v. Decker, 22 Va. App. 486, 493-94, 471 S.E.2d 775, 778 (1996). A letter opinion, unless and until incorporated by reference in a decree, is not itself a ruling but simply a direction to counsel as to how to prepare the decree. Consequently, the issuance of the letter opinion was not, standing alone, the equivalent of a decree of specific performance.
F.
The Bankruptcy Code's definition of a claim as including a right to an equitable remedy for breach of performance if such breach gives rise to a right of payment and the Code's provisions allowing a trustee or debtor in possession to reject executory contracts leave little doubt that Congress intended that the trustee's rejection rights trump state law remedies based on the theory of equitable conversion. See In re A. J. Lane Co., Inc., 107 B.R. 435, 438-39 (Bankr. D. Mass. 1989) ("It was well established under the prior Bankruptcy Act that the estate could reject a contract to sell real estate where the buyer was not in possession. The buyer's right to specific performance, and the doctrine of equitable ownership flowing therefrom, are subordinate to the estate's right of rejection") (citing Gulf Petroleum, S.A. v. Collazo, 316 F.2d 257 (1st Cir. 1963)). Indeed, were equitable conversion alone to carry the day, there would be no need for Congress to have provided in § 365(i), Bankruptcy Code, specific statutory protection for a contact purchaser in possession. Accordingly, if no other circumstance were present that dictated a different conclusion, this court would rule, consistent with the analysis in Young and A. J. Lane Co., that — at least where a contract seller has filed for bankruptcy prior to the entry of a decree of specific performance — a contract purchaser not in possession has no right to compel the bankruptcy estate to perform the contract unless the trustee or debtor in possession elects to assume the contract. The contract purchaser's sole rights, under those circumstances, are a lien against the property for any portion of the purchase price that has been paid, and a claim in the bankruptcy for monetary damages for breach of the contract.
G.
The question, therefore, is whether there are additional circumstances that would prevent the debtor in possession from rejecting the option contract. As noted above, early in this case the debtor brought, and the court denied, a motion to approve rejection of the contract.
In denying the motion, the court found that the option contract, viewed in the context in which it was executed, was intended as a security device. Xerox Realty had no particular desire to purchase the 545 acre parcel which it had previously sold to the Japanese investors two years previously. What Xerox Realty wanted to do, rather, was to sell the adjacent parcel to the debtor's affiliate, Lansdowne Development Company. In connection with that sale, however, it had joined with the debtor in a rezoning application to Loudoun County in which Xerox had incurred, in its view, significant monetary proffer obligations, and it wanted to be protected against that liability. The device by which it was ultimately to be protected was a deed of trust against the 545-acre parcel. That deed of trust would not be executed and recorded, however, until the sale of the larger parcel to LDC closed. Since the debtor's purchase of the WIUV property was occurring several months prior to the closing of the LDC parcel, Xerox negotiated for the purchase option as interim protection. The option agreement, which Xerox Realty's witness repeatedly referred to in his testimony as a "default remedy," allowed Xerox Realty to purchase the property back from UDC — for the amount of the outstanding indebtedness that Xerox Credit had guaranteed — if LDC failed to close on the contract for the larger parcel. As a security device, it could not be rejected any more than a deed of trust, had it been in place to secure the proffer obligations, could have been rejected. Accordingly, given the function that the option contract was intended to fulfill, the court ruled that the debtor could not reject it.
Xerox estimates the amount required to perform the proffers at $18 million. The debtor disputes this figure; disputes that Xerox, after selling the property, would have any personal liability for the proffer obligations; asserts that the proffer obligations are largely self-funding; and asserts that allocation of the proffer liability may be compelled between the 545 acre tract and the remaining 1,350 acres.
III.
The conclusion that the debtor in possession could not, under the unique circumstances of this case, reject the option contract, would seemingly require the recognition of Xerox Realty's state law rights arising under the principle of equitable conversion. The debtor however, argues that, regardless of whether the contract can be rejected under § 365, Bankruptcy Code, it may be set aside under other provisions of the Bankruptcy Code that give a trustee or debtor in possession the power to "avoid" certain types of transfers. The issue before the court, therefore, is whether any of those powers enable the debtor to set aside either the option agreement itself or the transfer of equitable title that occurred when Xerox Realty exercised that option.
A.
The debtor argues first that any transfer arising as a result of the option agreement can be avoided under the "strong arm" powers conferred on bankruptcy trustees by § 544(a), Bankruptcy Code, because no instrument reflecting the exercise of the option was ever recorded prior to the stated expiration of the option period.
Section 544(a), Bankruptcy Code, provides in relevant part:
(a) The trustee shall have, as of the commencement of the case, and without regard to any knowledge of the trustee or of any creditor, the rights and powers of, or may avoid any transfer of property of the debtor or any obligation incurred by the debtor that is voidable by
(1) a creditor that extends credit to the debtor at the time of the commencement of the case, and that obtains, at such time and with respect to such credit, a judicial lien on all property on which a creditor on a simple contract could have obtained such a judicial lien, whether or not such a creditor exists;
* * *
(3) a bona fide purchaser of real property, other than fixtures, from the debtor, against whom applicable law permits such transfer to be perfected, that obtains the status of a bona fide purchaser and has perfected such transfer at the time of the commencement of the case, whether or not such a purchaser exists.
It is clear that the statute is aimed towards implementing the goal of the bankruptcy laws to promote an equal distribution of the debtor's assets among its general unsecured creditors. 5 Collier on Bankruptcy ¶ 544.01, at 544-3 (Lawrence P. King, ed., 15th ed. rev. 1997). This goal is effected under § 544(a) by allowing the trustee to avoid most unrecorded interests in real property. See In re Stuckey, 126 B.R. 697, 701 (Bankr. E.D. Va. 1990) (Tice, J.). But see In re Smith, 348 F. Supp. 1290, 1293-94 (E.D. Va. 1972) (Merhige, J.) (in a case decided under the Bankruptcy Act of 1898, the court held that where the debtor holds legal title to property which is impressed with a resulting trust, the trust can be enforced against the debtor's judgment lien holders and thus against the trustee) (following Straley v. Esser, 117 Va. 135, 83 S.E. 1075 (1915)).
While the trustee's strong-arm powers are conferred by federal bankruptcy law, the nature and extent of those rights are measured by the applicable (here, Virginia) state law. Crestar Bank v. Neal (In re Kitchin Equipment Co.) 960 F.2d 1242, 1245 (4th Cir. 1992); Havee v. Belk, 775 F.2d 1209, 1218 (4th Cir. 1985); Angeles Real Estate Co. v. Kerxton (In re Construction General, Inc.), 737 F.2d 416, 418 (4th Cir. 1984); Phillips v. Chandler, 215 B.R. 684, 686 (E.D. Va. 1997) (Williams, J.); Stuckey, 126 B.R. at 701; 5 Collier on Bankruptcy ¶ 544.02, at 544-4 to 5. Clearly, § 544(a) bestows upon the trustee no greater rights or powers than those accorded under the applicable state law to a creditor holding a judicial lien or to a purchaser for valuable consideration without notice. Havee, 775 F.2d at 1219. Accordingly, the court turns to Virginia law to determine whether either a judicial lien creditor, or a bona fide purchaser for value and without notice, could defeat Xerox Realty's rights under the option agreement.
In Virginia, it seems clear that a option to purchase real estate, standing by itself, creates no present — or "vested" — interest in real estate, but only the right to acquire such an interest in the future. Ryland Group, Inc. v. Wills, 229 Va. 459, 464, 331 S.E.2d 399, 402-03 (1985), Springfield Engineering Corp. v. Three Score Development Corp., 26 Va. Cir. 186, 191 (1992). Nevertheless, the Virginia General Assembly has determined, through the enactment of §§ 55-57.1 and 55-57.2, Va. Code Ann., that an option is in the "nature of an interest in real estate which may be recorded and by that recordation protect the optionee's interest in the real estate." Springfield Engineering Corp., 26 Va. Cir. at 191.
The general recording statute in Virginia is found at Va. Code Ann. § 55-96. It applies, however, only to contracts, deeds, deeds of gift, and deeds of trust. In 1989, Virginia enacted a separate recording statute to protect holders of an option to purchase real estate vis a vis lien creditors and purchasers for value. Va. Code Ann. § 55-57.2(A). That statute provides, "Any option to purchase real estate, and any memorandum, renewal or extension thereof, shall be void as to (i) all purchasers for valuable consideration without notice not parties thereto and (ii) lien creditors, until such instrument is recorded in the county or city where the property embraced in the option, memorandum, renewal or extension is located." Since this statute is a relatively recent enactment, the case law interpreting it is sparse and provides no authoritative answer to the issues before the court. The court is required, therefore, to determine, based on the language of the statute itself, what the General Assembly intended when it enacted § 55-57.2(A).
When a federal court is interpreting state legislation, it must apply that state's rules of statutory construction. Phillips, 215 B.R. at 688. It is well established in Virginia that when the identical (or substantially identical) language is used in two different statutes that concern the same subject matter, the legislature intends the language to have the same meaning in both statutes. City of Virginia Beach v. Board of Supervisors of Mecklenburg County, 246 Va. 233, 236-37, 435 S.E.2d 382, 384 (1993); see also Pettengill v. United States, 867 F. Supp. 380, 382 (E.D. Va. 1994) (Smith, J.) (same, following Virginia law). The language employed in § 55-57.2(A), Va. Code Ann., is nearly identical to that used in § 55-96 and clearly affords the holder of a recorded option the same protection as a person holding a recorded deed or deed of trust. Once such an instrument is properly admitted to record under § 55-96, that recording protects the holder against any subsequent purchasers or lien creditors. This protection continues even after, for example, a deed of trust has matured and become due and payable. See Chavis v. Gibbs, 198 Va. 379, 387-88, 94 S.E.2d 195, 201 (1956).
In Chavis, the owner of certain real property, Joe Mitchell ("Mitchell"), gave a deed of trust securing the payment of two notes, payable in two installments, the second of which was due within 18 months. Id. at 380, 94 S.E.2d at 196. That deed of trust was recorded on September 8, 1928. Id., 94 S.E.2d at 196. Subsequently, Mitchell (and his wife) conveyed the property to a Charles Morris ("Morris") by deed recorded on November 1, 1929. Id., 94 S.E.2d at 196. This deed did not reference the deed of trust. Id., 94 S.E.2d at 196. Almost eight years later, on July 2, 1936, default having occurred on the two notes, the trustee under the deed of trust conveyed the property to the mortgagee; however, this deed was not recorded for over twelve years, on August 11, 1948. Id., 94 S.E.2d at 196. The mortgagee then conveyed the property to Louis Gibbs ("Gibbs") by deed recorded on November 20, 1948. Id., 94 S.E.2d at 196. Meanwhile, and shortly before the "foreclosure" deed was recorded, Morris conveyed the property under his deed from Mitchell to C. L. Chavis ("Chavis") by deed recorded on January 19, 1948. Id., 94 S.E.2d at 196. Consequently, a dispute arose between Gibbs and Chavis as to their respective rights and whether Chavis was a purchaser "without notice" of the deed of trust.
The then-Supreme Court of Appeals of Virginia held that Chavis took subject to the deed of trust that had long since matured and become due and payable, but which was within the statutory period for enforcement. Id., 94 S.E.2d at 201. After an extended discussion that a grantee is deemed to have constructive notice of all facts on record and those which might be disclosed upon a prudent inquiry, the court found that Chavis had both actual (under his deed, which stated that he took subject to the deed of trust) and constructive notice of the encumbrance. Id. at 382, 387, 94 S.E.2d at 197, 200. Notwithstanding the long period that had elapsed from when the notes secured by the deed of trust first became due and payable until the foreclosure deed was recorded, the court charged Chavis with the duty to inquire whether the lien of the deed of trust had been satisfied, or whether the property was foreclosed upon and sold. Id. at 387, 94 S.E.2d at 200. In response to the argument that such a duty would be an onerous task upon a grantee searching the land records, the court reasoned:
In Virginia, a deed of trust that has matured and become due and payable may be enforced for a period of up to twenty years, with the proviso that a period of one year shall be excluded from the computation of the time if a party in interest dies. Va. Code Ann. § 8.01-241. Presumably, the period of enforcement of an option contract to purchase real estate, once exercised, would be the five year statute of limitations for written contracts. See Va. Code Ann. § 8.01-246(2).
The answer to this is that any competent and prudent title examiner would have found the deed of trust. . . . He would have noticed that the debt thereby secured was long past due; that the rights of the holder of the lien in the event of default had accrued; that the lien had not been released on the margin; that there was no deed of release; and that the enforcement of the trust deed was not barred by the statute of limitations. Thus, the examiner would have been confronted immediately with the questions: whether the debt had been paid in part or in full, and whether in the event of default, the power of sale had been exercised.
Id. at 388, 94 S.E.2d at 201. Accordingly, the court found that Chavis did not take as a purchaser without notice. Id. at 388, 94 S.E.2d at 201.
Although there are no reported Virginia cases directly on point, the majority position in other jurisdictions appears to be that the same rule would apply in the context of an option — that is, any subsequent interests in the property are subject to the potential exercise of a properly recorded option, whether or not the period during which the option can be exercised has expired, and even if the option had yet to be exercised. See Barry v. Ippolito (In re Savel), 29 B.R. 858, 860 (Bankr. S.D. Fla. 1983) ("one that has notice of an option to purchase takes the property subject to that option, and the optionee may enforce it against third parties having notice"); Spokane School District No. 81 v. Parzybok, 633 P.2d 1324, 1325-26 (Wash. 1981) ("A subsequent owner, having notice of the option, takes subject to the optionee's right to complete his purchase. . . . [A]s between the optionee and a subsequent purchaser who had notice of the option right, the optionee has an interest in the land binding upon the purchaser, even though the optionee has not exercised his option or paid any part of the purchase price."); Daniel v. Kensington Homes, Inc., 192 A.2d 114, 120-21 (Md. 1963) (holding that a properly recorded option has the same effect as a deed and is binding as against subsequent purchasers); Thompson v. Thompson, 460 P.2d 679, 682 (Wash.Ct.App. 1969) (holding that once a real estate contract containing an option is recorded, that recording provides constructive notice of the option to subsequent purchasers of its possible exercise — even 12 years after the option was granted). But see Lowing v. Jaynes, 206 S.E.2d 162, 167 (N.C. 1974) (holding that once the period for exercising an option has expired, subsequent purchasers are not charged with constructive or actual notice that the option may have been exercised and may still be a viable contract as between the optionee and optionor).
A leading authority on property law shares this view:
If, before the option period expires, the owner of the property sells it to a another party who purchases it in good faith and without notice of the option, the owner of the property can be held liable to the option holder for monetary damages. The option holder can prevent this from occurring by recording the option document so that no one can purchase the property from the owner without having constructive notice of the terms of the option.
14 Powell on Real Property ¶ 879[2], at 81-12 (emphasis added).
There is no dispute in this case that Xerox properly recorded its memorandum of option on May 9, 1994, in accordance with § 55-57.1, and that the option could be exercised through August 1, 1996. It is also undisputed that Xerox in fact exercised the option on March 1, 1996, well within the option period. The recording of the memorandum, under the principles discussed in Chavis, was sufficient to provide constructive notice to subsequent purchasers for value of the possible exercise of the option within the option period, even though no further instrument was recorded reflecting that the option had, in fact, been exercised. Nothing in the language of the statute even remotely suggests that the General Assembly intended that some further recording had to take place after an option is exercised. Here, Xerox fully disclosed its interest in the property by recording its option pursuant to § 55-57.1. Under the teaching of Chavis, such recording would place a title examiner on notice of the option's existence and, if no release were found, would — at least within the statutory period for bringing suit to enforce the option — place the title examiner under the same duty of inquiry as if he or she had encountered a recorded deed of trust, the maturity of which had passed without a release being recorded in the land records. As to judicial lien holders, notice is simply not an issue, and the plain language of § 55-57.2(A) provides that once the memorandum of option is recorded, the holder of the option takes priority over a subsequent judgment lien. Accordingly, this court holds that, upon exercise of the option, Xerox Realty's equitable interest in the property was superior to that of subsequent purchasers for value and judgment lien creditors and remained superior even after the option period expired. Since under § 544(a), a bankruptcy trustee or debtor in possession occupies no higher position than a hypothetical judgment lien creditor or hypothetical purchaser for value, and since under Virginia law such a creditor or purchaser would take subject to Xerox's interest, it follows that the transfer of equitable title that occurred when the option was exercised cannot be avoided under the debtor in possession's strong arm powers.
The debtor places heavy reliance on the language "[a]ny option to purchase real estate, and . . . any renewal or extension thereof in Va. Code Ann. § 55-57.1 and argues that once the period specified in the option lapses, the option holder's perfected status terminates regardless of whether the option had been exercised or not. The words "renewal or extension," however, rather clearly refer to agreements granting additional time within which the option may be exercised, not to the natural delay that may occur between the exercise of the option and the actual conveyance of the property. In the nature of things, there will necessarily be some finite separation in time between the optionee's notice of intent to purchase, and the delivery and recording of a deed. Where, as here, the grantor of the option refuses to perform, the delay may well be quite considerable. But such delay in performance does not, in any usual or ordinary sense of the word, constitute an "extension" of the option.
The debtor's reliance on Springfield Engineering Corp. v. Three Score Development Corp., 26 Va. Cir. 186 (1992), for the proposition that the memorandum of option ceased to provide constructive notice after its stated expiration date, is misplaced. Springfield Engineering held simply that once an option period has expired, and the option is neither exercised nor extended, the optionee no longer has any interest in the real estate. Accordingly, the former optionee was not a necessary party to a mechanic's lien suit brought after the option period had expired.
Because the court concludes that the recording of the option agreement gave constructive notice of Xerox's interest in the property, it is not necessary to reach Xerox's additional argument that the recording of the memorandum of lis pendens on March 21, 1996, also gave constructive notice of its interest in the property. Nevertheless, some brief discussion is appropriate. The term "lis pendens" is Latin for "pending litigation" and refers to the common-law doctrine that one who purchases property, title to which is the subject of pending litigation, acquires no greater rights than his or her vendor had. Hart v. United Virginia Bank (In re Hart), 24 B.R. 821, 823 (Bankr. E.D. Va. 1982). At common law, the mere pendency of a suit provided constructive notice, but Virginia by statute now requires that a memorandum describing the suit and the property affected thereby to be recorded in the land records of the city or county where the property is located. Va. Code Ann. § 8.01-268. Once such a memorandum is recorded, however, the purchaser pendente lite takes whatever interest he or she has purchased subject to the final decree that may be entered in the case. Bray v. Landergren, 161 Va. 699, 172 S.E. 252, 256-57 (1934); Green Hill Corp. v. Kim, 842 F.2d 742 (4th Cir. 1988). Here, however, no final decree was ever entered in the action with respect to which the lis pendens was filed, because Xerox chose to dismiss that action and proceed instead with the state court action. No memorandum of lis pendens was filed with respect to the state court action until two weeks after the chapter 11 petition was filed. While the post-petition filing of the lis pendens did not violate the automatic stay, Gold v. McCarthy Construction Co. (In re Knightbridge Development Co.), 884 F.2d 145, 147 (4th Cir. 1989), it nevertheless could not have affected the interest, which arises as of the filing date, of a bankruptcy trustee under § 544, Bankruptcy Code, as hypothetical lien creditor or purchaser for value. Since on the filing date the only recorded memorandum of lis pendens related to a suit that had been dismissed, and since the only effect of a lis pendens is to subordinate a subsequent transferee's interest to the outcome of that suit, the lis pendens could not defeat the trustee's strong arm powers.
B.
As a second basis for avoiding Xerox's interest in the property, the debtor relies on § 548, Bankruptcy Code, which allows a trustee or a debtor in possession to set aside transfers occurring within one year of the bankruptcy petition that are made either with actual intent to hinder, delay, or defraud creditors or for less than reasonably equivalent value at a time when the debtor was insolvent or became insolvent as a result of the transfer. The transfer here, however, occurred on March 1, 1996, the date the option was exercised. Bauserman v. Digulian, 224 Va. 414, 419-20, 297 S.E.2d 671, 674-75 (1982) (equitable conversion occurs when option is exercised, not when it is granted). Since the date of the transfer is more than one year prior to the filing of the debtor's chapter 11 petition on June 5, 1997, § 548 provides no basis for setting it aside. The debtor attempts to get around this bar by arguing that Xerox Realty was "unperfected" on the date the bankruptcy was commenced, and that, accordingly, the transfer is deemed to have been made immediately before the date the petition was filed. See § 548(d)(1), Bankruptcy Code. In light of this court's ruling, however, that Xerox's interest was superior on the filing date to the interest of a hypothetical judgment lien creditor or purchaser for value, the debtor's argument necessarily fails.
The debtor also argues that the post-petition recording of the "amended" memorandum of lis pendens (referencing the Loudoun County action rather than the U.S. District Court action) constituted an unauthorized post-petition transfer avoidable under § 549, Bankruptcy Code. However, it is difficult to see how the filing of a lis pendens can be construed as a "transfer" in light of the Fourth Circuit's holding in Gold v. McCarthy Construction Co. (In re Knightbridge Development Co.), 884 F.2d 145 (4th Cir. 1989) that the post-petition filing of a lis pendens does not violate the automatic stay because in Virginia a lis pendens is not equivalent to a lien.
C.
The debtor's final avoidance argument relies on § 547, Bankruptcy Code, which permits a trustee or debtor in possession to avoid, as a preference, transfers made within 90 days of the filing of the petition on account of an antecedent debt if the debtor was insolvent at the time the transfer was made and the transfer enables the creditor to receive more than it would have received in a hypothetical chapter 7 liquidation had the transfer not been made. As with the fraudulent conveyance cause of action, however, the transfer in this case occurred on March 1, 1996, well outside the statutory period. Accordingly, the debtor cannot prevail on a theory that the granting or exercise of the option constituted a preference.
IV.
The debtor argues finally that, under the special facts of this case — and particularly given the court's prior ruling that the option contract could not be rejected because it was intended as a security device — to apply equitable conversion would violate Virginia's public policy against "clogging" or "fettering" the debtor's equity of redemption.
A.
When a mortgage is entered into, equity immediately grants the mortgagor the right, until a foreclosure is consummated, to redeem the mortgaged property by paying the mortgagee the amount of the debt, with interest. Snavely v. Pickle, 69-70 Va. 349, 351 (29 Gratt. 27, 34-35) (1877). This right is termed the "equity of redemption." Id. This right cannot be forfeited or impaired, even upon the consent of the parties, as long as the mortgage continues in effect as a security. Id. (29 Gratt. at 35); see also Humble Oil Refining Co. v. Doerr, 303 A.2d 898, 905 (N.J.Super.Ct. Ch. Div. 1973).
Any attempt to cut-off a mortgagor's equity of redemption is termed "clogging" or "fettering away" the equity of redemption and is void as against public policy. See Snavely, 69-70 Va. at 351 (29 Gratt. at 34-35); see also Blackwell Ford, Inc. v. Calhoun, 555 N.W.2d 856, 859 (Mich.Ct.App. 1996), app. den., 564 N.W.2d 46 (Mich. 1997); Ringling Joint Venture II v. Huntington National Bank, 595 So.2d 180, 182 (Fla.Dist.Ct.App. 1992), review den., 601 So.2d 553 (Fla 1992); Humble Oil, 303 A.2d at 907; Sally P. Falk, Note, Due-on-Sale Clauses and Clogging the Equity of Redemption, 36 Wash. Lee L. Rev. 1121, 1131-32 (1979). A clog on the equity of redemption is any provision that prevents a redemption of the property upon payment in full of the debt or obligation for which the security was given. Lincoln Mortgage Investors v. Cook, 659 P.2d 925, 927 (Okla. 1983); Blackwell Ford, 555 N.W.2d at 859. Moreover, it is well-settled in Virginia that extrinsic evidence may be offered to show that a conveyance absolute on its face was intended by the parties only as security for a debt, thus transforming the conveyance into a mortgage, with the concomitant right to an equity of redemption. E.g., Johnson v. Johnson, 183 Va. 892, 905, 33 S.E.2d 784, 788 (1945); Hunter v. Bane, 153 Va. 165, 170, 149 S.E. 467, 468 (1929); Kidwell v. Henderson, 150 Va. 829, 837, 143 S.E. 336, 339 (1928); Eggleston v. Eggleston, 127 Va. 334, 103 S.E. 603, 605 (1920); Holladay v. Willis, 101 Va. 274, 278, 43 S.E. 616, 617-18 (1903); see also Humble Oil, 303 A.2d at 909 ("It is clear that equity looks to substance rather than to form, and that a guarantor or surety who takes property or an interest therein as security for his guaranty is a mortgagee thereof in equity."). In order to transform an absolute conveyance into a mortgage, the grantor must prove that a debt is owed by the grantor to the grantee. Johnson, 183 Va. at 905, 33 S.E.2d at 789; Hunter, 153 Va. at 170, 149 S.E. at 468; Holladay, 101 Va. at 279-80, 43 S.E. at 618. The grantor must also demonstrate that the parties intended that the purpose of the conveyance was to be security for the debt. Johnson, 183 Va. at 905, 33 S.E.2d at 789; Hunter, 153 Va. at 170, 149 S.E. at 468; see also Blackwell Ford, 555 N.W.2d at 860.
The court in Lincoln Mortgage Investors noted that the following contract provisions have been held to clog the mortgagor's equity of redemption: limitations on the time in which to redeem, warranties not to redeem, limitations on who may redeem, provisions giving the mortgagee an option to purchase the security upon a default, and limitations on the quantity of property that may be redeemed. Lincoln Mortgage Investors, 659 P.2d at 927.
It appears, however, that an agreement or provision will clog the equity of redemption only when it is entered into contemporaneously with or as part of the mortgage transaction. See, e.g., Snavely, 69-70 Va. at 351 (29 Gratt. at 35); Lincoln Mortgage Investors, 659 P.2d at 927; Blackwell Ford, 555 N.W.2d at 859; Ringling Joint Venture II, 595 So.2d at 182; First Illinois National Bank v. Hans, 493 N.E.2d 1171, 1174 (111. App. Ct. 1986); Russo v. Wolbers, 323 N.W.2d 385, 389-90 (Mich.Ct.App. 1982); Humble Oil, 303 A.2d at 905-06, 908. Thus, subsequent to the original transaction, the mortgagee may purchase the mortgagor's equity of redemption, "if under the jealous scrutiny of a court of equity, it is shown to be for an adequate consideration, that no undue advantage has been taken of the necessities of the mortgagor, and that it is in all respects fair." Snavely, 69-70 Va. at 351 (29 Gratt. at 35); Dawson v. Perry, 30 Va. Cir. 372, 373, 376 (1993); see also Blackwell Ford, 555 N.W.2d at 859; Ringling Joint Venture II, 595 So.2d at 182; Russo, 323 N.W.2d at 389-90; Humble Oil, 303 A.2d at 908.
B.
In the present case, had the sale with LDC closed as contemplated, Xerox would have been protected, by the deed of trust for which it had bargained, against liability for the proffers incurred in connection with the rezoning. As interim protection against the possibility that the closing might not occur, Xerox bargained for the purchase option. The option was only exercisable upon a default by LDC, and once the deed of trust was in place, the option would expire. While getting the property back would not, in itself, indemnify Xerox against the proffer obligations, it would place Xerox, since it would control both parcels with respect to which the obligations were incurred, in a better position to protect its interests.
The rule against clogging the equity of redemption is in some respects simply a special case of the general rule that equity will relieve against a forfeiture if the other party to the transaction can be compensated. See 14B Michie's Jurisprudence, Penalties and Forfeitures, § 11 at 76 ("Affirmative relief against contractual penalties and forfeitures was one of the springs or fountains of equity jurisdiction and the jurisdiction was very early recognized. Where compensation can be made, a court of equity will always relieve against a penalty."); Asher v. Pendleton, 47 Va. (6 Gratt.) 628 (1850) (land purchase); Galvin v. Southern Hotel Corp., 154 F.2d 970 (4th Cir. 1946, affd 164 F.2d 791 (4th Cir. 1947) (lease); In re Murphy, 9 B.R. 167 (Bankr. E.D. Va. 1981) (agent's right to insurance premiums). Whether Xerox can be fully compensated other than by enforcing the terms of the original bargain involves hotly-contested factual issues that cannot be determined based on the summary judgment record. If, as Xerox contends, the combined proffer liability approximates $18 million and cannot be allocated between the 545 acre parcel and the remaining 1,350 acres, it is difficult to see how a sale of the 545 acres to a third party could possibly give Xerox the same level of protection that it would have if it had ownership of both parcels. The debtor asserts, however, that there is no realistic possibility that Xerox will ever be called upon to pay a dollar, let alone $18 million, since Loudoun County, it is argued, will look solely to the land and will be willing to allocate the liabilities between the two parcels. Furthermore, the debtor argues, the zoning proffers themselves set up a self-funding mechanism for financing the highway improvements that constitute the major portion of the liabilities. These are factual issues that can only be determined at trial.
V.
For the foregoing reasons, the court will deny the debtor's motion for summary judgment, and grant Xerox's cross-motion for summary judgment, with respect to Counts I, II, IV, and VI of the debtor's counterclaims. Both motions for summary judgment will be denied with respect to Xerox's claims and Count III of the debtor's counterclaims. A separate order will be entered consistent with this opinion.